I enjoyed reading Cabot Dividend Investor analyst Chloe Lutts Jensen’s reasons for recommending the Dividend Digest Spotlight Stock, including:
• Increasing dividends
• Diversification
• Low valuation
• Rising demand
Those catalysts rang a bell with me, as they reflect many of the same criteria that investors have utilized for a couple of hundred years to find fundamentally strong companies with great potential for gains. You see, these characteristics hark back to the very reason that the stock market exists: for growing companies to raise capital for further expansion, while rewarding their shareholders with dividends and appreciation over the long-term.
But in the past few decades, many investors have forgotten that premise, instead seeking overnight riches, concerned only with momentum trading and caring less about the actual companies.
Now, I’m not saying that you can’t make money by trading, but history proves that it takes lots of skill—and lots of time—to become a trading expert. I have many friends who trade the swings in the market, and they’re very good at it. But for most investors—folks with long-term plans—choosing strong companies with good prospects remains the key to profitable investing.
I’ve been utilizing this value/growth investing model for more than 20 years, and it has rewarded me with average annual gains of 29%. Most of my criteria are simple to employ, and include these fundamental characteristics:
• Reasonable debt so that the company is not over-extended during challenging economic cycles
• Good cash flow from the primary operations of the company, with deep cash pockets ready to be employed for expansion and acquisitions
• Low price-earnings ratios, compared to its peers and its historical valuation, so that you are buying the shares at a discount
• Double-digit growth in sales and earnings, which tend to lead to higher stock prices
• Reasonable—but growing—institutional interest, which often predates rising share prices
But, of course, a company could pass these tests with flying colors and the shares may still linger at rock-bottom prices. Consequently, I want see some kind of momentum that tells me the shares are acquiring market interest. So I add a few technical indicators to the model. Two of my favorites are:
• Moving average, the average of a security’s prices over specific time periods. It is used to determine a trend based on past prices, and to determine support and resistance levels in the shares. It can be calculated for very short time periods and much longer ones. Traders generally use the short period moving averages, while long-term investors favor the moving averages that look at a stock for a longer period. I tend to look at both the 50-day and 200-day moving averages in order to get a better picture of where a stock may be headed.
• Relative Strength Indicator (RSI) compares the magnitude of recent gains to recent losses to determine overbought and oversold conditions. RSI ranges from 0 to 100. If a stock reaches an RSI of 70, it’s typically considered overbought, and if it trades at 30 or less, it may be considered oversold.
Each of the indicators I have mentioned can be found on most financial websites, and I encourage you to learn more about this age-old, proven method of investing.
I was around when investors in the tech boom of the late 1990s called Warren Buffett—the world’s greatest value investor—a has-been, because he was still using his tried-and-true method of investing and ignoring the high-flying tech companies with no fundamental strength. Well, we can see who came out ahead, can’t we? At 80+ years of age, Buffett still has a fantastic portfolio of companies returning exponential gains. It’s something to think about, isn’t it?
